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Edited version of private advice
Authorisation Number: 1051581669542
Date of advice: 17 September 2019
Ruling
Subject: Valuation of goodwill for CGT purposes
Question 1
Is the market value of the goodwill of the business considered to be nil for the purposes of calculating a capital gain or loss made under section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997) under the Proposed Transaction?
Answer
Yes.
This ruling applies for the following period
1 July 2019 to 30 June 2021
The scheme commences on:
1 July 2019
Relevant facts and circumstances
Background
The Partners run a business via a partnership. The partnership holds most of the assets and liabilities of the business, however an asset that is critical to the running of the business is held by a related entity. The business also utilises assets that are owned by unrelated third parties.
The partners, the partnership and their related entities are all Australian residents for tax purposes.
The Business
The business involves the utilisation of standard industry procedures and equipment. The machinery used, labour employed and processes implemented assist in deriving the end product, are generally consistent with industry practices in 2019.
The business does not have any registered brands, logos, trademarks or other marketing products. The business has no agreements in place to products with any third parties.
The business has informal agreements in place, however all agreements are able to be cancelled by either the lessor or lessee with reasonable notice and no penalty.
The properties subject to the leases used by the business may be sold by the lessor without any legal requirement for the informal arrangement to be continued on with a potential purchaser.
Proposed Transaction
The Proposed Transaction includes the following steps:
1. A new private company (NCO1) shall be established for business trading.
2. A new family discretionary trust (NDT) shall be established with a new private company (NCO2) also established to operate as trustee of NDT.
3. All of the shares in NCO1 shall be held by NCO2 in its capacity as trustee of NDT.
4. All of the assets and liabilities relevant to the business shall be transferred to NCO1 at market value.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 102-20
Income Tax Assessment Act 1997 Section 104-10
Income Tax Assessment Act 1997 Subsection 104-10(1)
Income Tax Assessment Act 1997 Subsection 104-10(4)
Income Tax Assessment Act 1997 Section 116-20
Income Tax Assessment Act 1997 Section 110-25
Income Tax Assessment Act 1997 Section 960-400
Reasons for decision
Summary
The market value of the goodwill of the business is nil for the purposes of calculating a capital gain or loss made under section 104-10 of the ITAA 1997 under the Proposed Transaction.
Detailed reasoning
Section 102-20 of theITAA 1997 provides that an entity will make a capital gain or a capital loss if a capital gains tax (CGT) event happens to a CGT asset.
Subsection 104-10(1) of the ITAA 1997 provides that CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law.
Pursuant to subsection 104-10(4) of the ITAA 1997, you make a capital gain from CGT event A1 if the capital proceeds from the disposal are more than the asset's cost base.
As defined in section 116-20 of the ITAA 1997, capital proceeds from a CGT event are the total of the money and the market value of any property received or entitled to be received in respect of the event happening.
All the assets and liabilities of the business will be transferred to NCO1 for market value.
Section 960-400 of the ITAA 1997 provides that the expression 'market value' is used in the income tax laws with its ordinary meaning. The most common definition for market value is derived from Spencer v. Commonwealth (1907) 5 CLR 418. In that case it was held that a valuation of land should be based on the price that a willing purchaser at the date in question would have had to pay to a vendor not unwilling, but not anxious to sell.
The ATO market value guidelines state that the valuation of goodwill is generally based on the calculation of a residual value. In basic terms, this approach requires the valuation of the net identifiable assets of the business (market-adjusted) and the valuation (market value) of the equity of the business.
A residual value may be derived by subtracting the value of the net identifiable assets of the business from the value of equity of the business. As a general rule, the calculation of a residual value will be the most appropriate method for deriving goodwill. However, other methods may be accepted if they are appropriate to the circumstances.
Based on the information provided, it is accepted that the market value of the goodwill of the business is nil.
It is expected that the cost base of the goodwill of the business under section 110-25 of the ITAA 1997 will be nil. As the capital proceeds from the transfer of the goodwill are also accepted to have a market value of nil, no capital gain or loss will be made upon the disposal of the goodwill of the business to NCO1.